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Aggregate Supply, Aggregate Demand, and Coal

I’m back — and, as you can see from the time of posting, jet-lagged up the wazoo. Also, now I have to deal with matters parental, which means very limited blogging for a while.

But I did want to say something about President Obama’s new climate initiative — which has, by the way, received weirdly little coverage. Yes, I know there’s other stuff going on — but people who are serious about climate policy regard this as what Joe Biden would call a BFD. Not only does it offer a chance of substantial action despite Republican obstruction, there was a tone to the speech suggesting that Obama may put serious effort into this thing, that he may see climate policy as the big legacy of his second term.

Lots more analysis will, I hope, be forthcoming, from both the environmental and the economic side. But there’s one crucial economic point I want to get out there right away: while the usual suspects will denounce all this as job-destroying regulation, tougher climate policy will, almost surely, be job-creating, not job-destroying, under current conditions.

Why? Well, ask yourself first how, exactly, pollution regulations are supposed to destroy jobs. They will indeed raise costs, that is, shift up the aggregate supply curve. But our economy isn’t supply-constrained right now, it’s demand-constrained; so why would this make a difference? Even if prices go up a bit, how will this reduce real demand? It’s like the argument about wage flexibility, which I’ve addressed many times in this blog: downward flexibility of wages does nothing helpful when you’re in a liquidity trap, and cost increases do no harm.

So, no job cuts. Why might new regulations actually be expansionary? Because they will provide power companies with an incentive to invest in ways that will reduce their emissions, even if they currently have excess capacity. Obama had a great phrase near the end of his speech: “Invest, divest” — that is, shift away from more to less polluting ways of doing business. And the “invest” part would be exactly what the economy needs. Yes, this is a variation of the “termites” theory, under which wrecking capacity can actually be expansionary — but that theory is right under these conditions.

In short, everything you’re going to hear about the downside of the new regulations will be wrong, at least for the short to medium run.